After listening a recent NPR Planet Money podcast on CEO pay and thinking over my own experience, I’ve come to the conclusion that despite our best, well-researched intentions, incentive compensation can be a minefield of unintended consequences.
A very short story: In the 90’s, CEOs were paid based on the size of the company. As a result many were paid very well just for showing up and it didn’t matter how the company performed. The company hits rough times and you have to lay off workers? No problem! Ms. CEO is still getting paid her six+ figure salary.
The government changed some tax rules and inadvertently introduced the world to “pay for performance” which led to the development of stock options. The podcast walks through a simple explanation of how options work and illustrates the consequences of this new method of compensation.
Fast forward to the post-recession 2000’s and people are still upset about CEO pay. There is evidence that the highest paid CEO’s perform the worst and companies are paying out unprecedented levels of CEO pay relative to average employee pay.
For all the details on the evolution of CEO pay, check out the Planet Money Podcast, episode 682, When CEO Pay Exploded.
Why Should The Average HR Pro Care?
I understand that the average HR pro, or compensation consultant may never have much influence on a Fortune 500 CEO’s pay, BUT there is still a huge lesson here. Anytime you change people’s pay there may be unintended consequences.
Most HR professionals contemplating a change in incentive compensation typically evaluate the changes respective to some important questions:
What is the impact to the bottom line at various levels of performance?
How does the plan measure up to market compensation? Laggard? Leader?
Performance being equal, is the plan fair?
Does the plan support the organization’s overall strategy?
I’m sure there is a much longer list of questions but you get the idea.
Now that we’ve covered the basics, how can we better plan for unintended consequences? How do we design a lucrative individual plan but maintain teamwork? Or, how do we ensure there is enough room in the plan to truly differentiate your top performers from the low performers?
Make planning for unintended consequences a step in your process:
Plan – Take a cross-functional approach to help you identify possible unintended consequences. Your actions in one group likely affect other groups. For example, if you have a very lucrative sales plan, can the manufacturing plant actually produce all the widgets that your salespeople are heavily incented to sell?
Communicate – Remember the resources you used to plan? Use them to brainstorm ideas on how you can best anticipate questions and consequences.
Touch Base – Quarterly check in’s with plan participants can help you get a feel for what is working and not working.
Update – Your plan will not be static. Business evolves at a rapid pace and the incentive plans you have in place should be re-evaluated on a regular basis to ensure that they are incenting the right performance.
So yes I still think incentive compensation can be a minefield. Tweak too much in one corner and you can get negative consequences in a different corner. But what’s the alternative? Pay everyone a base salary and use the annual merit cycle as an incentive? I hope you made a face when I said that. You won’t be able to anticipate every outcome but that can’t be an obstacle. Ship it!